Initial Pricing Principle

The Commerce Commission is coming in for considerable flack for its role in determining the price of Chorus’s wholesale service and it’s worth reviewing what the Commission is required to do and why it’s doing it.

The Commission is governed by several acts of parliament not least of which is the Commerce Act itself, which has been since 1986 and has flaws enough but which allows for the creation of the Commerce Commission itself.

A relatively new part of the Commerce Commission is the Telecommunications Commissioner’s role, something which was created in 2001 to oversee the telco sector in New Zealand. Prior to that, we had no industry specific regulation, no regulator and for those of you with a long memory, no real competition in the market.

The Telco Commissioner was required to conduct periodic reviews into a number of areas, one of which was the price Telecom charged its competitors for using its network. This service, unbundled bitstream access (UBA) was assessed on a “retail-minus” basis. That is, Telecom told the Commission what its various retail plans were, the Commission took an average number from those plans, removed a margin and presented Telecom with its wholesale price. This price was reviewed regularly but generally speaking it’s been the primary product most ISPs in New Zealand re-package and sell as their own broadband service.

In effect, for many years we had no choice but to buy the Telecom product, either from Telecom or from an ISP that simply changed the name and re-sold the same product.

I’ve long argued that this isn’t wholesale per se – it is in fact resale. The ISPs had limited control over the product, couldn’t specify changes they’d like to see introduced, couldn’t really differentiate at all.

In 2010 the newly appointed Minister of Communications Steven Joyce introduced a new version of the Telecommunications Act (the third in a decade) as part of the sweeping changes the government would be introducing. The main plank of the policy was the introduction of the UFB project and the promise of government funding to any provider that built the network.

The minister also introduced a Supplementary Order Paper that added in a few caveats including the infamous regulatory holiday for the company that built the UFB, but as part of that SOP the Minister also required the Commission to do two other things: firstly, to average the price of unbundled services between rural and urban New Zealand (previously we had two prices) and to stop this constant round of assessing the price of wholesale service.

The Minister ordered a change to the “initial pricing principle” (IPP) which governs the way the Commission must assess pricing. Out went retail minus and in came “cost based” pricing. To quote from the Telecommunications Act itself (Part 2 – Designated Services):

Initial pricing principle: Benchmarking against interconnection prices in comparabl countries that result from the application to networks that are similar to the access provider’s fixed PSTN of— 
(a) a forward-looking cost-based pricing method

Bearing in mind this is in the law itself – there’s no room for the Commission to say “we don’t think this is a good idea”. Far from it – the Commission has expressed its concerns about retail-minus as a model for many years, as has TUANZ. The ability for any incumbent to game the system by introducing a handful of very expensive plans and so skew the average was always too much to endure and we saw ISPs complaining bitterly that some of the retail plans Telecom offered were priced below the wholesale cost to its competitors.

As I said yesterday, there’s no way to use retail minus when your network operator is structurally separated and has no retail arm. What would you do – assess prices right across the board from all ISPs and work backwards from there?

The only option is to move to a cost-based model, and as that’s what the law requires, that’s what the Commission has done.

I’ve called the Commission on mistakes in the past: the original TSO decision was a travesty that lumbered the market with an utter nonsense for nearly a decade. The decision not to unbundle in 2003 was poor and did not serve us well.

I even question the price point for LLU services announced yesterday – it seems odd to me that prices for connectivity haven’t fallen by more than $4 in five years.

But on the matter of using a cost-based analysis to determine the wholesale price of service from Chorus, the Commission has no choice – it is the law.